By Caroline Humer
NEW YORK, Oct 26 (Reuters) - The pharmacy at the center of
suspicions over Valeant Pharmaceuticals (N:VRX) International Inc's
VRX.TO VRX.N business practices began as a small pilot
project two years ago and quickly grew to account for 7 percent
of the drugmaker's revenue.
Valeant disclosed on Monday details of its relationship with
Pennsylvania-based Philidor Rx Services, defending the pharmacy
against allegations of illegal activity while pledging to review
the business carefully.
Few Valeant investors had heard of Philidor until last week,
when influential short-seller Citron Research said it was being
used to create "phantom accounts" and inflate the drugmaker's
revenue. Valeant immediately denied the allegations, but shares
in the company tumbled as investors questioned its pharmacy
ties.
"When you ... construct an unusually complex and not
transparent way of doing things, the first question is: 'Why
didn't you do it the standard easy way?'," said Erik Gordon, a
professor at the University of Michigan's law and business
schools.
Valeant explained on Monday that the pharmacy began as a
pilot under Medicis Pharmaceutical Corp, a maker of anti-wrinkle
medicines and facial fillers that Valeant acquired in 2012. By
January 2013, Valeant began studying how to build up the
program, known at the time as the Medicis Alternate Fulfillment
Program.
The pharmacy passed on discounts paid for by Valeant to
patients with commercial insurance, often reducing their
out-of-pocket costs to zero and helping them to pay for
medicines that they could not otherwise afford. When the patient
was covered, Valeant would bill insurance companies for
reimbursement.
This process effectively denied patients access to cheaper
or alternative drugs and circumvented the way health insurers
typically pay pharmacies for drugs.
The program grew from distributing two drugs to at least 10
Valeant medications, including steroid cream Locoid and acne
treatment Solodyn, Valeant said on Monday. Its biggest success
may be distribution of the toenail fungus treatment Jublia, as
Philidor now handles 44 percent of the drug's sales.
Philidor now is licensed in 46 states and the District of
Columbia, and also distributes drugs through affiliates in
California, Florida, New Jersey, South Carolina and Texas.
The company said it was ready to cooperate with Valeant's
committee reviewing its business.
"Philidor's relationship with Valeant has benefited
countless patients by ensuring they receive their medication
quickly and efficiently," Philidor said in a statement.
Philidor's rapid rise led Valeant to spend $100 million in
late 2014 on a 10-year option to buy the company for $0. The
deal terms include other target-based payments of up to $133
million, $33 million of which have already been paid, it said.
Valeant said that Philidor was considering looking to other
drugmakers to expand its business model, and the purchase option
was meant to stabilize its ties to the distributor.
As part of their agreement, Valeant members sit on a joint
steering committee with Philidor management, and the drugmaker
has the right to influence hiring of key personnel, though it
cannot replace the chief executive or management.
"We do not own or control Philidor," Valeant board member
and former Chief Financial Officer Howard Schiller said during
the conference call.
The size of the purchase option was below the company's
standard for disclosure, Valeant said. Together with the fact
that Valeant accounted for Philidor revenue as intercompany
sales, the pharmacy dealings were undetectable in its quarterly
financial reports.
In order to comply with accounting standards, Valeant said
that it consolidates Philidor revenue as its own, and also that
of other specialty pharmacies in the network. That includes R&O
Pharmacy, a California specialty pharmacy that is part of
Philidor's network. In recent months, Valeant sent a collection
letter to R&O for not paying it for medicines distributed
through its network. R&O has since filed suit against Valeant.
Philidor also has an option to acquire Isolani, another
specialty pharmacy. That pharmacy in turn owns a 10 percent
stake in and the option to acquire the rest of R&O. Isolani
provides management and administrative services to R&O while
Philidor provides back end services, Valeant said.
The intertwined companies had employees who worked for both
Valeant and Philidor, the Wall Street Journal reported on
Monday. Valeant did not address that point, but said that the
board committee would look into that issue.
Charles Elson, a corporate governance expert at the
University of Delaware, said that the committee will likely take
weeks or months to report on its findings.
"They believe there's a problem. That's really all we can
say for sure," Elson said.